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Stock Expected Return Starbucks 0.18 Sears 0.08 Arcade 0.16 Limited Brands 0.12 Considering the informtion provided below: R f = 0.06, E(R m ) =

Stock

Expected Return

Starbucks

0.18

Sears

0.08

Arcade

0.16

Limited Brands

0.12

Considering the informtion provided below:

Rf= 0.06, E(Rm) = 0.16, Rm = 0.2

a) Derive the equations of the Security Market Line (SML) and the Capital Market Line (CML), show them graphically and determine the equilibrium prices of the total risk and the systematic risk.

b) Discuss the effects of an increase in the risk aversion in the market in terms of both the CML and SML.

c) If you decide to invest $4,000 in Starbucks, $6,000 in Sears, $12,000 in Arcad, and $3,000 in Limited Brands, find the expected return and the risk of your portfolio as measured by beta.

d) Assuming that the prices of the above stocks are realized as follows:

Stock

P0

P1

Evaluation

Decision

Starbucks

40

45

Sears

22

25

Arcade

25

29

Limited Brands

40

45

Determine whether the above stocks are overvalued, undervalued or priced fairly, and indicate your decision.

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